Earlier this year, I moved from the Gulf Coast to Jackson, Mississippi. It was a nice step up in terms of housing as I said goodbye to my roommate and the 1,100-square-foot home we shared for two years. Then in the middle of moving, I met a harsh reality about my new locale as a massive hailstorm hit the neighborhood. The same storm system produced tornados that leveled a western Mississippi town in March. I needed a new roof and as I type this, roofers are hard at work hammering away at repairs to my home. Then last week, another dangerous system damaged much of my hometown of Moss Point.
I can’t say whether these extreme weather events are the result of climate change, but they do appear to be outside of the norm. I use my story anecdotally because even if this weather in Mississippi isn’t caused by climate change, an increasing amount of extreme weather around the world is. And this is beginning to hit pocketbooks of individuals and companies more than in the past.
The Impact of Physical Risk
Beyond the human impacts of violent weather, a business question emerges: Who pays for the repairs? So far, the answer for the most part has been insurance companies, but that may change soon. Homeowners insurance rates rose 2.8% on average in 2023 alone, capping a cumulative 19.1% since 2018. Part of that increase is certainly due to general market conditions, but a portion can be attributed to rising natural catastrophes. In 2022, natural catastrophes in the U.S. resulted in $98.9 billion in insured losses. This put pressure on the insurance sector and earlier this month, State Farm and Allstate both decided they will no longer sell new home insurance policies in the state of California, citing increased wildfire risks.
This is likely just the beginning of a trend in new limitations on what insurers are willing to cover. I believe certain geographic areas will face heightened insurance costs or limitations on available insurance in the years to come, causing ripples throughout the economy. After all, if a project can’t be insured, then no bank will be willing to finance it. Limitations in financing result in limitations to development. More limited development means an already tight housing market will become even tighter; real estate will continue to rise in value as the construction sector struggles to keep up with demand. On top of this, storm events or wildfires might further reduce housing inventories – especially where insurance is not available for rebuilding homes lost.
All of this adds up to physical risk playing a major role in decision-making. Businesses will need to account for rising insurance premiums or increased retention levels in their business planning. Additionally, rising insurance costs may make certain locations too costly and projects that may have been lucrative ten years ago may now be deemed too risky.
Beyond Physical Risk
Even if your company can get a project insured and financed, can your employees afford homes in the area if insurance costs skyrocket or if coverage is denied outright? If not, you could face a shortage of human capital and struggle to attract proper talent. Projects being built today may run the risk of becoming stranded assets in ten years’ time if proper attention is not given to these risks in the development process.
D&O insurance policies are turning more attention to the effects of ESG as increasing scrutiny leads to higher regulatory and litigation risks. Allianz’s Directors and Officers Insurance Insights 2023 lists ESG in the top five risk trends boards and management need to guard against right now. As climate becomes too important to ignore, reporting requirements for company GHG emissions grow. The SEC’s upcoming climate-related disclosure rule, as well as reporting schemes like the CSRD in the EU, are introducing new reporting requirements for companies around the world.
With these new requirements comes the risk of reporting errors and claims of oversight failures which can factor into a company’s D&O insurance. It’s not just climate-related disclosures either. Supply chain and human rights laws are increasing reporting obligations for companies as well. For example, the EU’s CSDDD and Canada’s new Bill S-211 will require companies to report on what, if any, measures they are taking to combat forced labor in their supply chains.
Lawsuits present another risk area driving D&O policies. We’ve previously discussed the risks presented by rising ESG litigation to businesses. In a D&O context, ESG cases are arising that target directors and officers. These range from climate cases brought by activist investors (which argue that insufficient climate planning is a breach of a director’s fiduciary duty), to diversity litigation alleging that conduct of directors has run afoul of anti-discrimination laws. The good news for companies is that, unlike homeowner’s insurance, the cost of D&O insurance has decreased dramatically since Q1 2020 driven by market conditions. It remains to be seen if these costs will increase when proposed reporting regimes become binding laws.
What this Means
Whether you’re insuring a physical asset or buying D&O insurance, conducting proper risk assessments is a top priority in managing your insurance costs, risk retention levels and shielding yourself from liability. In the realm of physical risks, a forward-looking approach must be taken. Changing climates and weather patterns mean that some areas are dealing with unprecedented issues, so historical data alone may not be reliable. It would be prudent to understand how the areas your business operates in are changing and what unique risks are posed by those changes.
For D&O insurance, change is also a major theme. Increasing reporting requirements will result in additional uncertainty. With that uncertainty comes a higher chance of an error, inaccuracy or misrepresentation in your reporting. Stay on top of upcoming reporting obligations and ensure that your company is building capacity for compliance. Additionally, strong social policies, healthy DEI programs, and inclusive culture reduce the risk that a director or officer can be held liable in discrimination litigation.
For more on ESG risk evaluation and management check out our E&S Risk Reduction Concepts and Valuations Guidebook as well as our How to Conduct an ESG Materiality Assessment Guidebook.